Concerns have been swirling in the cryptocurrency market for months about the status of Tether, a cryptocurrency issued by Tether Limited. It plays a central role in the operation of many leading cryptocurrency exchanges, including Bitfinex, but there is speculation that the company behind it may not hold the dollar reserves it claims.

If this theory is true, it has the potential to crash the price of bitcoin and potentially hobble the operations of many exchanges. Here's what you need to know:

What is Tether?

The Tether symbol.Tether
Tether is a cryptocurrency that's meant to be backed one-for-one by the US dollar. The idea is to have the price stability of the dollar combined with the operational ability of a cryptocurrency. It's what people in the crypto world call a "stable coin."

Who uses Tether?

"Anybody who's trading on some of the major exchanges [holds Tethers]," Mati Greenspan, a market analyst with eToro, told Business Insider. "What exchanges like Bitfinex do is, rather than having a client's balance held in dollars, they hold them in USDT. So if somebody's got their money on an exchange such as Bitfinex and they don't have any current open positions, they're actually probably in Tether."

Many cryptocurrency exchanges have difficulty working with traditional banks, who are wary of working with crypto businesses. Tether offers a stable alternative, offering the low volatility of the dollar to both exchanges and users.

An industry source who didn't want to be quoted told BI: "Tether is used by crypto-to-crypto exchanges as it allows them to price crypto assets in USD without having to maintain/own USD-denominated bank accounts - this is of particular interest to many platforms due to the difficulties involved in maintaining banking relationships in the crypto space."

Tether's website says that it "allows you to store, send and receive digital tokens person-to-person, globally, instantly, and securely for a fraction of the cost of alternatives." Holding client funds as Tether means exchanges can cut down on transaction costs until a client wants to redeem their funds as dollars. Then, Tether can be exchanged for those dollars.

Traders also use USDT to lock in returns during times of volatility and also transfer funds from one platform to another.

Why are people worried?

The company that controls and issues Tether is meant to hold US dollar reserves to back up all of the Tethers that have been issued — a little like the Federal Reserve backstops dollars with gold. In theory, Tether holders can sell one USDT back to Tether Limited for $1.

Bitfinex and Tether share management teams.REUTERS/Dado Ruvic/Illustration
But fears have emerged in the cryptocurrency community that Tether Limited doesn't hold sufficient currency reserves to back all the Tethers in circulation.

"The claim is — and the claim has been growing lately — that they're not holding those reserves," Greenspan told BI. "They haven't been incredibly transparent about where they're holding them and how much they're holding in different places."

The report claims that the printing of Tethers tends to coincide with a dip in the price of bitcoin, suggesting it may be being used to buy up cheap bitcoin. "Tether printing moves the market appreciably; 48.8% of BTC's price rise in the period studied occurred in the two-hour periods following the arrival of 91 different Tether grants to the Bitfinex wallet," the analysis said.

$850 million worth of new Tethers have been printed in January alone and many market participants are worried about the pace at which new Tethers are being minted without proper documentation showing their backing.

What does the company behind it say?

Tether Limited has strongly denied all the accusations against it, insisting that it has the dollar reserves to back up all Tethers in circulation and saying it is using its funds properly.

The company said in a statement in December that it is aware of "questions and doubts throughout the community" but said it "cannot disclose much about ongoing investigations," related to the hack in November.

"We confirm that the relationship with Friedman is dissolved. Given the excruciatingly detailed procedures Friedman was undertaking for the relatively simple balance sheet of Tether, it became clear that an audit would be unattainable in a reasonable time frame. As Tether is the first company in the space to undergo this process and pursue this level of transparency, there is no precedent set to guide the process nor any benchmark against which to measure its success.

"We remain committed to the process and, as we've consistently done, we will continue to provide material updates at the appropriate times."

The company told Bloomberg in an email responding to the CFTC subpoena: "We routinely receive legal process from law enforcement agents and regulators conducting investigations. It is our policy not to comment on any such requests."

What happens next?

"I hope that this whole thing gets shaken out as soon as possible," Greenspan told BI. "The uncertainty isn't very good for the market."

After a huge price run-up before Christmas, the price of bitcoin has collapsed by around 40% in January. Other cryptocurrencies have seen similar retractions. While this slump is not driven by Tether fears, the issue comes at a jittery time for cryptocurrencies.

The next steps for Tether are somewhat unclear at this stage. Possible scenarios include further action from US regulators or Tether Limited engaging a new auditor to look over its books.

He said: "That means Bitfinex has issued Tether under the eye of the CFTC since then, which in important ways suggests the coin is indeed backed by USD. If Bitfinex has been issuing Tether not sufficiently backed by USD, despite being under CFTC monitoring, it'll be one of the most brazen acts we've seen from an exchange in this space."